You’ve heard it before; compound interest is better than simple interest. Right? And maybe you’ve even seen Albert Einstein’s quote that compound interest is the eighth wonder of the world.
What is really important is if you understand compound interest, you set yourself up to earn it. If you don’t understand it, then you may be paying it. And while you may agree with all your heart about earning compound interest, it does NOT mean you need to have all your money in a bank to earn it.
I want to be sure I don’t leave anyone behind in this conversation:
Compound interest is when interest is paid upon interest, so the amount of interest paid grows each year on the original amount deposited or invested.
With simple interest, the interest paid stays the same year after year.
As an example, we made a loan to a company that finances people that flip houses. We earn 7% every month, month after month, year after year. It does not grow.
My wife and I have apartment buildings and each year the tenants get a small rent increase. As an example, if the rent is $1000 per month, the 2nd year we might request a 2% increase, which would be $20.
If we provide a 2% increase each year, in year three the increase is $20.40. By year five, the increase is $21.23, and now the total rent paid is $1082.84. And in year six, the rent increase would be 2% x $1082.84.
If this were simple interest, a 2% increase in year five would still be $20, and the rent would only be $1080.00. While that $2.84 difference does not look like much on a small amount, as investments grow, the amount becomes substantial.
I have an example in my book on page 141 that shows the earnings are larger than the annual deposits 30 years in the future. It would take up too much space here to go through the complete example.
Are you paying compound interest, or are you earning it?
To Your Prosperity,